Endogenous Uncertainty in a General Equilibrium Model with Price Contingent Contracts

This paper views uncertainty and economic fluctuations as being primarily endogenous and internally propagated phenomena. The most important Endogenous Uncertainty examined in this paper is price uncertainty which arises when agents do not have structural knowledge and are complelled to make decisio...

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Bibliographic Details
Published in:Economic theory 1996-10, Vol.8 (3), p.461-488
Main Authors: Kurz, Mordecai, Wu, Ho-Mou
Format: Article
Language:English
Subjects:
Contracts
Economic fluctuations
Economic theory
Economic uncertainty
Endowments
Equilibrium models
Equilibrium prices
Financial risk
Financial securities
General economic equilibrium
General equilibrium model
Market equilibrium
Pareto efficiency
Prices
Symposium: Rational Beliefs and Endogenous Uncertainty
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Summary:This paper views uncertainty and economic fluctuations as being primarily endogenous and internally propagated phenomena. The most important Endogenous Uncertainty examined in this paper is price uncertainty which arises when agents do not have structural knowledge and are complelled to make decisions on the basis of their beliefs. We assume that agents adopt Rational Beliefs as in Kurz [1994a]. The trading of endogenous uncertainty is accomplished by using Price Contingent Contracts (PCC) rather than the Arrow-Debreu state contingent contracts. The paper provides a full construction of the "price state space" which requires the expansion of the exogenous state space to include the "state of beliefs." This construction is central to the analysis of equilibrium with endogenous uncertainty and the paper provides an existence theorem for a Rational Belief Equilibrium with PCC. It shows how the PCC completes the markets for trading endogenous uncertainty and lead to an allocation which is Pareto optimal. This paper also demonstrates that endogenous uncertainty is generically present in this new equilibrium.
ISSN:0938-2259
1432-0479
DOI:10.1007/BF01213505